As the Federal Reserve raised interest rates four times this year, many fixed income investors looked to manage duration risk by embracing low duration bonds and the related exchange traded funds, including the iShares Short Treasury Bond ETF (NYSEArca: SHV) and iShares 1-3 Year Treasury Bond ETF (NASDAQ: SHY).
Although the Fed could slow its pace of interest rate increases next year, managing duration risk should still be a priority for bond investors.
“With a flat yield curve and relatively tight credit spreads today, you don’t need to take on much interest rate risk or rely on higher-risk assets like stocks to generate income potential,” said BlackRock in a recent note. “High-quality ultrashort- and short-duration bonds are sitting in a sweet spot right now: they offer potentially attractive yields, and their short duration means they’re less exposed to interest rate risk (duration).”
SHV tries to reflect the performance of the ICE U.S. Treasury Short Bond Index, which is comprised of U.S. Treasury bonds that mature in less than 1 year and provides targeted access to a specific segment of the U.S. Treasury market. The ETF comes with a 0.15% expense ratio, a 2.32% 30-day SEC yield and a 0.41 year duration.
SHY tries to reflect the performance of the ICE U.S. Treasury 1-3 Year Bond Index, which is made up of short-term U.S. Treasuries to better help investors customize their exposure to the Treasuries market. The fund has a 0.15% expense ratio, a 2.58% 30-day SEC yield and a 1.85 year duration.
“We haven’t yet seen a material uptick in bond market volatility,” said BlackRock. “As and when that may happen, though, we tend to see credit risk increase with it. Consider that the two-year Treasury currently yields nearly 3%, according to Bloomberg. Rotating into an ETF like the iShares 1-3 Year Treasury Bond ETF (SHY) can be a low-cost way to up the overall credit profile of your portfolio. You might even be able to capture a tax loss, as market prices for investment-grade corporate bonds have declined somewhat.”
SHY and SHV are among this year’s most popular bond ETFs. SHV has seen 2018 inflows of $11.87 billion, a total surpassed by just four other ETFs. Investors have allocated $8.97 billion to SHY, a total exceeded by six other ETFs.
For more information on the fixed-income markets, visit our bond ETFs category.